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Tax Terms & Definitions Legal Tax Angles: How to Save Taxes Without Going to Jail The terms and phrases explained below are not defined in an exact manner. The following explanations represent a plain English translation of the applicable terms based on my understanding of the terms. These definitions were initially prepared to accompany various opinions letter to clients regarding the use of a private annuity, employee stock options, foreign corporations and some other topics. As time permits, I will try to add to this list of tax law and international tax explanations. [ Vernon Jacobs ] Accrual Method of Accounting – An accounting method is which revenue is recognized as income when it is earned, even though not received and expenses are recognized when incurred even though not yet paid. (See Cash Method) Adjusted Basis - The cost of property after adjustment for certain deductions or additions as permitted or prescribed by the U.S. tax laws. In some instances, the basis of property is derived from the basis of other parties - such as a donor or an estate. Adjusted Gross Income (AGI) - The total income of a taxpayer before deducting any itemized deductions or personal exemption allowances. Alien – A person who is not a citizen of the USA Alternative Minimum Tax (AMT) – A method of determining taxable income and the amount of tax due for high income taxpayers and corporations that uses rules significantly different from the rules used in the “normal” method of taxation. The initial purpose of this alternative tax scheme was to reduce the opportunities for total tax avoidance with various tax deductions and credits. Annuity - Generally, any series of payments. In the context of a private annuity, it’s a series of payments for the life of the annuitant or annuitants, which is also known as a life income annuity. Annuitant - The person who receives an annuity, usually as payment for cash or other property, also known as the settlor or transferor Appreciated Property - Property with a fair market value greater than its initial cost without regard to its tax basis At-Risk – These rules impose restrictions on deductions or credits to the value of indebted property that is subject to loss by the taxpayer. These rules primarily deny deductions or credits arising from debts for which the taxpayer is not personally liable. Avoidance of Tax – Legal methods of tax minimization or reduction Basis - see adjusted basis Bearer Shares – Shares of the stock of a corporation that are not registered. Whoever has possession of the bearer shares owns that portion of the net assets and net profits of the corporation. Bearer shares are often used to hide or disguise the ownership of the corporation. Buyer (of annuity) - See obligor and transferee Capital Assets - Any assets that are not (1) inventory in a trade or business, (2) depreciable personal or real property, (3) certain works created through the personal effort of the taxpayer, (4) business accounts and notes receivable, and (5) certain U.S. publications. Depreciable personal property and real property are subject to special rules for measuring the amount of any gain or loss but they are similar to those of other kinds of capital assets. Capital Gains - For tax purposes, this is a gain on a capital asset Capital Loss – For tax purposes, this is a loss arising from the disposition of a capital asset wherein the property is sold for less than its adjusted basis. Cash Method of Accounting – A method of accounting in which income is not recognized until it is received and expenses are not recognized until they are paid. (See Accrual Method of Accounting.) Certificate of Deposit (C.D.) -- An obligation of a financial institution to hold a deposit and to return it and to pay interest at a future maturity date. Check-the-box – A method of selecting the form of taxation of an entity whereby a partnership, limited liability company or foreign corporation can elect to be taxed as a corporation or as a partnership (where there are multiple owners) or as a ‘disregarded entity’ where there is only one owner. Commercial Annuity -Generally an annuity issued by an insurance company. An annuity that is not a private annuity. Controlled Foreign Corporation (CFC) - a foreign corporation in which over 50% of the stock is held by U.S. persons who each own 10% or more of the stock. Cost - The amount paid for an investment for tax purposes. See Adjusted Basis. Deferred Payment Annuity - an annuity in which the first payment to the annuitant by the obligor does not begin until more than a year after the annuity payment was made by the annuitant. Depreciable – Property that declines in value over time and for which the tax law permits annual deductions to approximate the annual loss of value of the property. Depreciation – The amount of a deduction from the initial value (cost basis) of property to reflect the decline in value over time. Direct Investments - An investment held in the name of the individual taxpayer. Disregarded Entity - A legal entity that elects to be taxed as if it were a partnership (more than one owner) or as a proprietorship (one owner.) The election is made on Form 8832. Domestic - For federal tax purposes, an entity organized under the laws of one of the fifty states of the U.S. For the purpose of state law, this would apply to any entity organized in and subject to the laws of that state. Earnings and Profits - This is a difficult concept to describe briefly, but it basically represents the accounting income of a business as contrasted with the taxable income of the business. E & P is computed without use of certain accelerated deductions for depreciation and with some other adjustments. Entity - An “entity” is an organization other than a natural person. It includes but is not limited to corporations, partnerships, trusts or estates. Estate Tax – A tax based on the value of property transferred at death. The tax is based on a graduated set of rates ranging from 18% to 49% and is not applicable until the taxable estate exceeds the unified credit amount. Evasion of Tax – Illegal methods of tax minimization or reduction, which usually involves some element of secrecy or deception.
Expatriation – The
act or process of relinquishing citizenship or of changing the country of
permanent residence. The term expatriate is also used to describe someone who
is living and working outside of the
U.S.
even though that person has no intention of losing their citizenship or
permanent residence status. Fair Market Value - An amount that would be paid by a willing seller and accepted by a willing buyer, both of whom are under no compulsion to buy or sell and both of whom have full knowledge of the significant facts about the property. Family Limited Partnership – A limited partnership that is owned entirely by members of the same family. Fee Simple - The unrestricted ownership of property by an individual. Fiscal Year – An accounting year that begins on a date other than January 1st and ends on a date other than December 31. The choice of a fiscal year is generally available only to corporations. Flat Tax – This is a term used by advocates of an income tax system with a single tax rate. Some tax reform proponents advocate a flat or single rate tax based on the sales price of goods or services – which is the same as a sales tax. Foreign Corporation - A corporation domiciled (located) in a different country or state. Foreign Grantor Trust - A trust (formed by a U.S. person) that is located and administered outside the U.S. The U.S. person who funds the trust is generally treated as the owner of the assets of the trust for tax purposes, in accordance with tax code sections 671 through 679. For U.S. tax purposes, a foreign trust is one in which all of the significant decisions of the trustee are not subject to the jurisdiction of a U.S. court. Foreign Mutual Fund – See Passive Foreign Investment Company Foreign Partnership – A partnership that is based in a foreign country or state. Foreign Persons - Foreign means a non-resident of the U.S. who is a citizen of another country or an entity organized under the laws of another country. In the context of state law, the term refers to any entity not organized under the laws of that state. Also, see non resident alien. Foreign Tax Credit – A credit from U.S. income taxes for the amount of income taxes paid to a foreign country on the same income. Form 926 - Statement of transfers to or from a Controlled Foreign Corporation Form 1116 – Foreign tax credit for individuals Form 1118 – Foreign tax credit for corporations Form 3520 and 3520-A - See Foreign grantor trust. Form 5471 - See Controlled Foreign Corporation and Foreign Corporation Form 8621 – See passive foreign investment company Form 8832 - See disregarded entity Form 8865 – See foreign partnership. Form TD F 90-22.1 - A return to disclose the existence and authority over a foreign bank account or other foreign financial account. FPHC - A foreign personal holding company (see personal holding company and foreign corporation) G.A.A.P. (Generally Accepted Accounting Principles) – A set of rules for the measurement or determination of income and net worth in the financial records of an enterprise. There are different methods of GAAP in different countries. Gift - A gratuitous transfer of property or money for less than the fair market value of the property with the intent to make a gift. Gift Tax – A tax based on the value of property transferred to others without consideration. The tax is based on the graduated set of rates used for the federal estate tax and is not applicable until the accumulated gifts by a taxpayer exceed the unified credit amount. Grantor - The person who creates and funds a trust, usually for the benefit of another, where the person who funds the trust is treated as the owner of the trust assets under tax code sections 671 through 679. High Yield Investment Programs - Alleged investments, usually from countries that do not have strict securities disclosure laws, that promise returns substantially higher than are available from traditional sources. The great majority (if not all) of these "investments" are Ponzi schemes in which the investments of new participants are paid to the earlier participants as a way to encourage them to spread the word about the investment. HYIP - High Yield Investment Programs IBC - International business company or foreign corporation. Imminent Risk of Dying - This means there is at least a 50% medical probability that the annuitant will survive for at least a year. Income Tax – A system of taxation based on earnings from employment, profits from self employment, income received from investments and capital gains from the sale of property. The U.S. income tax system permits numerous exemptions, exclusions and deductions and utilizes a graduated tax rate structure ranging from a bottom rate of 10% to a top rate of 35%. Indirect Investments - An investment held by an intermediate legal entity such as a corporation or trust, rather than in the name of the individual taxpayer. Internal Revenue Code - The Laws enacted by the U.S. Congress to define the tax obligations of U.S. persons. Investment in the Contract - For tax purposes, this is the amount that is paid by the buyer of an annuity for the annuity, plus or minus various adjustments. This is generally equal to the basis of the property being sold, plus any gain that may be recognized on the transaction. Imputed Interest Rates - Interest rates that are assumed when there is no explicit rate in a specific transaction. For this purpose, the amount of an annuity payment includes an imputed interest factor similar to the interest rate on an installment sale. The applicable federal (interest) rate is prescribed by tax code section 7520 and changes each month. International Business Company - a corporation that is usually located in a low tax country that is not allowed to conduct business in that country. IRC - Internal Revenue Code or tax code. IRS - Internal Revenue Service Joint Annuitant - A person who is one of two or more people who will receive annuity benefits in a joint and survivor annuity contract. Joint and Survivor Annuity - An annuity in which the payments continue after the death of the first of two or more annuitants until after the death of all the annuitants who are parties to the contract. Joint Ownership With Right of Survivorship – Property that is owned by two or more persons with an undivided interest in the property. Also referred to as “tenancy in common” or “joint tenancy”. Life Expectancy Tables - The Internal Revenue Service has published tables of the average life expectancy of single annuitants and joint annuitants at various ages as set forth in the IRS regulations 20.2031-7A. Life Income Annuity - An annuity that ceases at the death of the annuitant, with no further obligation to the estate or heirs of the annuitant. Limited Liability Company (LLC) - A legal entity that protects the members from personal liability arising from damages caused by the LLC or its employees. The LLC also helps to protect the assets owned by the LLC from the creditors of members (owners) of the LLC. Limited Partnership - A partnership with two types of partners. General partners manage the partnership and are liable for any debts of the partnership in excess of the partnership assets. Limited partners have no personal liability for debts of the limited partnership beyond the amounts invested. Long Term Capital Gain or Loss – A gain or loss on a capital asset that may be subject to special tax treatment if the asset has been owned for more than a year by the seller. Generally, long term capital gains are subject to a maximum tax rate of 20% for individuals and long term losses are only deductible against any capital gains in the same year or to the amount of $3,000 of other income. Medicare Tax – A tax of 2.9% of the wages of an employee, half of which is paid by the employer and half of which is paid by the employee through withholding. Self employed persons pay the entire Medicare tax on their taxable profits. Member – The term used to designate the owners of a limited liability company and to distinguish from partners or shareholders. Mortality Risk - The risk of financial loss as a result of issuing an insurance contract on a person who survives for less for than the average life expectancy or as a result of issuing an annuity contract to a person who lives longer than the average life expectancy. Non Resident Alien - A person or entity that is not a citizen of the United States and is not a permanent resident of the United States. Obligor - The person or company that is obliged to make the annuity payments, also known as the transferee or buyer (of the property) Offshore -- Usually refers to tax havens but it could apply to any country other than the country of residence or citizenship. Ordinary Income - For tax purposes, this is a category of income that does not enjoy any special tax advantages. For purposes of an annuity contract, the imputed interest and the element of the payment that represents compensation for the termination of the obligation at death are taxed as ordinary income. Original Issue Discount (OID) - The reduction in the issue price of a fixed income obligation (bond or note) below the redemption price. The difference represents interest that will be added to the redemption value of the obligation over time, instead of paying interest in regular intervals. (See tax code sections 1272-1275) Payroll Taxes – A variety of taxes that are imposed on the amounts paid to employees. In the U.S. this usually includes the Social Security Tax, the Medicare Tax and the federal and state unemployment tax. Passive Activity Loss – A loss resulting from an investment in a business enterprise in which the taxpayer is not an active participant. Passive Foreign Investment Company – A foreign corporation in which 75% or more of the corporation’s gross income consists of passive investment income (such as interest, dividends and capital gains) – or – a foreign corporation in which 50% or more of the assets of the corporation are used or held for the production of passive investment income. Personal Holding Company (PHC) - A corporation in which over 60% of the income is earned from passive investments rather than from an active business, and which meets other conditions as set forth in IRC sections 541 through 547. Personal Property – Generally consists of tangible property that is not real estate. PFIC – See Passive Foreign Investment Company Present Value - The immediate value of an amount or series of amounts that are not due until a future date. Generally, the present value of a future sum is the amount that would accumulate to equal that sum at a specified rate of interest (compounded) for a specified term of years. Private Annuity - Generally an annuity contract that is not issued by an insurance company or is not a commercial annuity. Qualified Electing Fund (QEF) – A passive foreign investment company in which a U.S. shareholder has elected to report and pay taxes on the shareholder’s portion of the annual income of the company. Real Property – Land, buildings and improvements. Related Persons - Generally this includes a spouse, children, parents or grandchildren and any entities such as partnerships, corporations or trusts in which the taxpayer or anyone related to the taxpayer has effective control over the entity. Resident Alien - A person who lives in the U.S. for an extended period but who is not a citizen of the U.S. A resident alien is subject to the U.S. tax laws in substantially the same manner as a U.S. citizen. Qualified Appraisal - A formal valuation and appraisal analysis by a qualified appraiser who specializes in making appraisals of the subject property. The appraiser must be independent of the annuitant and the obligor. Sales Tax – A tax based on the retail sales price of goods and services that is collected by the vendor of the goods or services. Self Employment Tax – A tax imposed on the taxable profits of a proprietor or partner based on 15.3% of the taxable profits up to $87,000 (in 2003). Half of the total self employment tax is allowed as a deduction in computing adjusted gross income. Seller - See transferor and annuitant Settlor – The person who creates and provides the funds for a trust. Shareholder – The owner of stock of a corporation, which normally entitles the holder of to vote on the selection of directors and certain other matters as set forth in the by-laws of the corporation. Social Security Tax – A tax of 12.4% of the wages of an employee in the U.S. for wages up to $87,000 (for 2003). Half is paid by the employee through payroll withholding and half is paid by the employer. Stock Options - A contractual right to purchase or to sell a specified number of shares of corporate stock, at a set price, for a specified period of time. Subpart F - The group of tax code sections (951 - 964) that define the income of a controlled foreign corporation that is subject to current taxation by certain shareholders of the CFC. Tax Shelter – An investment or financial transaction that is designed to generate substantial tax deductions or credits. An abusive tax shelter is one that the IRS regards as having no economic, business or financial purpose other than to avoid taxes. Terminally Ill - See imminent risk of dying. Transferee - The person or organization that receives property in exchange for an annuity; also known as the buyer or obligor Transferor - The annuitant who transfers property for the annuity; also known as the seller of the property Trust - A contractual relationship between the owner of property (the grantor), a manager of the property (the trustee) and a beneficiary, whereby the trustee manages the property for the benefit of the beneficiary in accordance with the contractual terms set by the grantor. Unified Credit – For 2003, the unified credit is $345,800, which is equivalent to a deduction of $1,000,000 from a taxable estate. In 2004 and 2005, the credit is $555,800, which is equal to a deduction of $1,500,000. Unrelated - A natural person who is not related to the taxpayer by blood or by marriage, or a legal entity that is not subject to the control of the taxpayer. Unsecured Contract - The general credit of the obligor/transferee is the only form of security available to the annuitant. No collateral or other methods of ensuring payment by the obligor may be utilized. U.S. Person - A U.S. person is a citizen, a resident alien individual, a domestic trust, estate, partnership or corporation. Value Added Tax (VAT) – A method of taxation based on the sales price of various goods or services wherein the amount of VAT paid by suppliers is deducted from the total due by the seller. The VAT is used in many countries other than the U.S.
Vern Jacobs Copyright, 2003 |
Books and Services by Vern Jacobs
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